GameStop betting digital distribution is far, far away

GameStop has a business model that might have a shorter half-life than the company's executives would like to admit. The retailer makes the majority of its profits from used games and systems, and from selling high-margin items such as controllers and strategy guides. The large chain has a major question to answer in the next few years: what happens if/when the majority of games are sold online, directly to consumers? So far the answer isn't encouraging: "don't worry about it, digital distribution is a long way off."

Sterne Agee analyst Arvind Bhatia reported on a study conducted by GameStop brass, and the data suggests that gamers won't have the technology needed to download games directly until 2014, and even then only 25 percent of the market will be set up for digital distribution. The research also indicates that consumers would only pay $39.99 for games, meaning prices for software—especially on consoles—would have to come down.

Even then, GameStop believes that it has a place in the new direct-sales ecosystem. "Management... feels that digital growth and brick and mortar growth can co-exist," Bhatia explained. "Through their brick and mortar locations, the company can help facilitate and capitalize off digital. Overall, management did not seem at all concerned about the near-term threat but instead is looking at ways to potentially profit from digital."

GameStop has a large budget and teams of analysts at its disposal to help research data points for these conclusions, and we'll likely never see the extent of their digging into the future of digital distribution, but it's hard not to be skeptical of this timeline. All you need to download games is a roomy hard drive and a broadband connection, and neither of these things are rare among the game-playing public.

In other words, the future is now; digital downloads are grabbing hold of the market much quicker than anticipated.

Publishers have a huge incentive to move in this direction: digital downloads can't be resold or bought used, and the industry has never been comfortable with GameStop profiting by selling the same physical game over and over. Larger retailers such as Walmart and Best Buy might not mind ditching low-margin items such as new games, only keeping a stock of hardware that can be sold alongside high-margin accessories and warranties. This stops the cycle of "buy game, trade it in, buy another used game," but GameStop doesn't have many other ways of turning a profit.

Gamers in rural areas and those without high-speed connections will remain customers of physical media, but it's clear that publishers and console manufacturers are invested in the idea of digital distribution and are expanding their offerings aggressively. We still need storage to get a bit cheaper, and connections to get a little faster, but these aren't large obstacles and will take care of themselves in time.

Does GameStop have an actual plan to deal with the new digital marketplace? Surely. Historically, however, those selling buggies didn't adapt quickly enough to make money off the car movement. The big names in digital distribution are already setting up virtual shops, and their names are Sony, Microsoft, Nintendo, and Valve. If GameStop waits too long to stake its own claim, there may be little left to monetize.